The Biden Administration tax package did not pass before Congress went on the holiday break so it’s unlikely to affect your 2021 tax return.
However, December 31 is the deadline for most of the steps you can take to lower your tax liabilities. So let’s look at some ways you can maximize deductions, apply some tax-savvy investing techniques and avoid penalties and fees.
Check on your FSA and HSA accounts
Review your Flexible Savings Account (FSA) plan’s rules for rolling over unused funds. Then, spend down any use-it-or-lose-it balances left over by paying for qualified health care expenses before the year ends.
Do you have access to a high-deductible health insurance plan? If so, explore whether a Health Savings Account (HSA) wouldn’t make sense. Those plans have lower monthly fees.
And the HSA itself offers a triple tax benefit – you get a tax-deductible contribution, tax-deferred growth and tax-free withdrawals on funds used to pay for qualified medical expenses. Best of all, you can accumulate any unused HSA funds year after year – and have them available even in retirement. So, contribute as much as you can each year.
Maximize your retirement account contributions
As an employee, you must make contributions by December 31 for any 401(k)s, 403(b)s, 457s, or other employer-based plans. Also, see if you want to change your contribution strategy next year after reviewing how your funds are invested. Check for any hidden fees, too.
With individual accounts, you have until April 15, 2022, to fund your IRAs or HSAs for the 2021 tax year. However, figure out now how you will fund those contributions.
Remember that the SECURE Act removed the 70 1/2 age limit on contributing to traditional IRAs as long as you have earned income.
Make beneficial conversions of eligible IRAs to Roth IRAs
With market values as high as they are, does it make sense to convert traditional IRAs to Roth IRAs now? And, on the other hand, is the threat of tax rate increases and tax bracket changes enough justification to convert? To help you decide, see if there is room left in your existing tax bracket to absorb the untaxed amounts you might roll over from your IRA.
Roth conversions must be completed by December 31 and are no longer reversible, so the move must be considered carefully. If you earn more than the Roth IRA income limits, explore existing after-tax conversion strategies for 2021 because those rules may change after this year. A tax planner, preparer or other financial professional may help identify your best strategies for present and future tax burdens.
Take your Required Minimum Distributions (RMDs)
In 2020, as part of COVID relief, people over age 72 or those holding inherited IRA accounts were given a break from taking RMDs. But those requirements are back for 2021 and must be taken by Dec. 31, based on the IRS formula. Failure to do so results in high penalties.
Accelerate any deductible expenses
Unless you think your tax rate may be higher next year, you may want to prepay any deductible expenses in December that are due after the new year. For example, consider advancing state and local income tax estimated payments, but be sure you haven’t reached annual deduction limits.
Identify your losses
Do you have any money-losing positions or investments in your portfolio? If so, harvesting tax-deductible losses may reduce your taxable income and make up for some recognized gains. However, the IRS is inflexible about its 30-day wash rule: purchasing the same (or substantially identical) security within 30 days from selling it at a loss could disqualify the deduction for capital loss.
Review your overall asset allocation to reflect any changes experienced this year and your expectations for the years to come. Your portfolio might need rebalancing to meet your goals and your risk tolerance.
Explore your charitable giving options
You can gift up to $15,000 each year to as many people as you like without affecting your lifetime exemption of $11.7 million ($23.4 million as a couple). However, the gift and estate tax exemption will likely be reduced dramatically in 2022. So, a strategy conversation with a tax or financial expert could be worthwhile. Gifts must be made by December 31.
Considering today’s higher standard deductions, combining several years of qualifying charitable contributions into one year may be attractive. (Standard deductions are $12,550 for individuals, $25,100 for married couples filing jointly, and higher for those over age 65.)
Also, contributing to a donor-advised fund could make sense if you itemize and don’t have the time before yearend to decide where to contribute. Major fund companies, universities and individual charities offer such accounts with differing minimum investment requirements, rules and fees. In addition, the funds in your account grow tax-free until you contribute them to a qualified charity.
Look into setting up Qualified Charitable Distributions (QCDs)
A QCD is a charitable donation made from your IRA by your IRA custodian directly to a qualified charity. It counts toward that year’s RMD requirement, and the amount donated is excluded from your taxable income. Additional benefits? Lowering your income may lower Medicare premiums and taxes due on Social Security. And lowering your IRA balance may also reduce the RMD amounts in the future.
Do a general end-of-year review
Even items that do not have yearend deadlines can benefit from an end-of-year review. So much has changed in the past year, and you may want to update things such as:
- Healthcare and Medicare plans
- The beneficiaries on insurances and retirement accounts
- Estate plans
- Fiduciary designations, such as executors and trustees
Look at what’s unique about 2021 taxes
Some unique tax issues generated by the pandemic could merit review:
Special payments such as delayed stimulus payments, refunds or reimbursements for overpaid taxes on unemployment income could call for follow-up.
Enhanced 2021 Child Tax Credit payments will be reconciled on your 2021 return.
Unemployment benefits are considered federally taxable income. Unemployment rules and payments vary by state, so be sure you are meeting any estimated taxes or taxes due.
On COVID-related retirement plan withdrawals, up to $100,000 withdrawn in 2020 was not subject to the 10% early withdrawal penalty. Also, the tax payment could be made over three years, and repayment of some or all of the money would render that portion nontaxable. Review the exact status of any withdrawals you took.
Everyone’s financial picture is different. Some are straightforward, and others are complex. As a result, no list can be all-encompassing.
However, if something sounds interesting – yet you are not that familiar with it – consider reaching out to a tax advisor or other financial professional to ensure you get the most significant benefit without putting yourself at risk.
Contact us to discuss year-end tax moves that might make sense for your financial situation.
This article originally appeared in Old Colony Memorial